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William Anders became CEO of defense giant General Dynamics in 1991 as the Cold War was ending and as the industry became saddled with excess capacity. Observing that the company was underserving shareholders and required a massive change in its culture, Anders brought in a new management team and introduced a new compensation system that better aligned the interests of managers and shareholders. Particularly controversial was the Gain/Sharing system, which paid large cash bonuses for each $10 increase in the stock price. The plan was widely criticized for rewarding top executives for manipulating stock prices through public announcements of layoffs and divestitures. Still, by the end of 1991, the stock price had climbed 113%, representing a $1.2 billion increase in shareholder wealth during the year. Teching Purpose: This case can serve several purposes. First, it provides an introduction to executive compensation. Second, it highlights the importance of linking incentives and corporate strategy in the context of a declining industry. Finally, the case can motivate discussions of downsizing and unemployment and the merits of rewarding top executives for cutting excess capacity.

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Discusses the 1989 modified performance appraisal program by adding performance gradations and allowing for differences in employee rating distributions depending on the division performance for the year. The objective is to have students discuss the revisions in the plan, focusing on the effects of forced-distribution ranking systems with flexible targets.

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In late 1986, Merck revised its performance review and pay practices. The most important change was a shift from an absolute rating system to a forced-distribution system in which managers are forced to adhere to a given distribution of performance ratings. Other major revisions included revised rating categories, revised performance categories, and a shift in the timing of performance evaluations. A discretionary award program was also introduced. The objective is to have students discuss the costs and benefits of the revised performance plan, paying particular attention to the relative performance evaluation aspects of the new plan. Is it better than the plan it replaced? Is pay more closely related to performance under the new plan?

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Merck & Co., Inc., a major pharmaceutical company, is in the process of reviewing and evaluating its personnel policies and practices. Employee interviews revealed that rewards for excellent performance were not adequate: outstanding performers received salary increases that were, in many cases, only marginally better than those given to average performers. In many cases, outstanding performance was not even clearly identified. The objective is to have students wrestle with a common malady of performance appraisal systems: the tendency of managers to assign uniform ratings to employees regardless of performance. Alternative appraisal systems should be suggested and discussed.

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Attention to how much CEOs are paid diverts public attention from how they are paid. A statistical analysis of executive compensation concludes that top executives are not receiving record salaries and bonuses; annual changes in executive compensation do not reflect changes in corporate performance; and with respect to pay for performance, CEO compensation is getting worse. Compensation policy not only shapes how top executives behave, it also helps determine the kind of executives an organization attracts. Boards of directors must reform their compensation practices and adopt systems that reward outstanding performance and penalize poor performance.

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